China's Debt Bomb Just Keeps Getting Bigger

Amid the ceremony of the 19th Party Congress in October, while conversations switched between which loyal acolyte is on the way up, and which diminished reformer might just hang on, two rather striking pieces of research appeared that exposed the crumbling foundations of China's economic miracle. Both of them provide strong reasons to doubt not only China's long prophesied rise to regional, and even global, pre-eminence, but also much of the "China rising" narrative that has accompanied the last decade or so.

First Victor Shih, associate professor of political economy at UC, San Diego -- who has been warning since at least 2009 that China's debt problem is far worse than people think -- published a report with the Mercator Institute for China Studies that paints an ugly picture of rising liabilities and de-facto insolvencies. Shih places Total Non-Financial Credit in China at about 328% of GDP, significantly higher than many other observers.

The IMF for example, which keeps warning of the perils of debt, estimates China's total debt at 230% of GDP, while remarking on the rapidity of its rise in recent years and forecasting that it will breach 300% by 2022. The difference between the two figures is striking, but part of a familiar pattern for China stats.

The most widely quoted figure for Total Debt is nearer 260% which has the advantage of official recognition, being the figure published by the National Development and Reform Commission (who produce and oversee the 5 Year Plans) but many analysts have long regarded this to be an underestimate. Partly because of doubts over official figures, Shih compiles his data from only the most reliable estimates. There are, however, other more speculative, alternative accounts.

Outlandish revelations?

The most impressively negative assessment concerning China's debt problems can be found in a reading of documents published by the PBOC Financial Stability Board in October. For the first time, well known and reasonably reliable "on balance sheet assets" can be combined with "off balance sheet" assets and measured -- according to the PBOC's own figures -- at "more than double" where they were before: or in other words, at an astonishing 833% of GDP. This all appears in a blog post by Christopher Balding, associate professor at HSBC Business School, Peking University.

The findings are currently being chewed over by quite a few China-focused economists, and the debate over their exact meaning continues, but there is no doubt a heightened concern over the reliability of numbers coming out of China.

A Darkening Mood(y's)?

The last week or so, however, saw the temperature of this debate rise again with another warning from Moody's, and another scolding missive from the IMF, calling on China to "prioritise financial stability over development goals," or in plain speak, stop hosing money around to keep the growth figures on target.

The problem is that as speculated debt levels rise, so the implied risk of a correction magnifies, which in turn forces economists to look a little harder at the numbers. If, on examining the numbers, they turn out to be less reliable than previously assumed this merely adds further uncertainty to a problem of enormous scale, encouraging beads of sweat to accumulate on the temples of hitherto optimists. When this happens, there arrives a point when reassuring platitudes about the China miracle and the millions brought out of poverty start to seem insufficient as a guide to the future.

Psychologists have long understood that in disaster scenarios most people behave strangely, going through normal routines in abnormal situations, like fetching luggage down from overhead lockers as water pours in the gaping hole in the side of the ship, or waiting for the fasten-seat-belt sign to turn off as fire spreads through economy class. The conclusion they draw is that in stressful or shocking situations, the human mind finds it difficult to adjust to rapidly changing circumstances. It is comforting to assume this behavior is limited to disaster scenarios, but given when financial corrections occur, they often turn out to have been quite obvious ... in retrospect, it is also tempting to think disasters might offer more general insights into how human minds ignore evidence that runs counter to cherished beliefs.

Deleveraging as Discourse

This year has seen China's growth rate keep pace with expectations, even perhaps improve a little. But this has also been accompanied by repeated reminders that no serious reform would either happen or be announced before the Party Congress in October. Predictably, there has been no serious reform, and while the Chinese government constantly refers to the need to deleverage, there has been no serious deleveraging. Indeed debts just keep rising, in some sectors faster than ever before. For example, Local SOEs and Local Government Finance Vehicles rose by 21% in the first nine months of this year, to $48 trillion yuan ($7.2 trillion). For comparison, just this increase alone is larger than all of Russia's economic output in 2016, according to IMF figures.

It has been said before, and it will doubtless be said again, that China bears are an endangered species, constantly proven wrong by the passage of time. But the numbers are still the numbers, and they all point in one direction. A recent missive from "Tyler Durden" -- the pseudonymous oracle of doom from the fringes of Wildweb -- is more lurid than most, but he claims that even record credit creation to Q3 2017 failed to stimulate the economy at all. This may, in the end, be overdoing it, but as with the IMF, Moody's, S&P's, etc., the direction of travel is all downhill. And while some forecasts are inevitably more dramatic than others, sincere refutation of inevitable outcomes must eventually amount to more than simply, "it hasn't happened yet."